IRS Proposes Regulations to Implement Loss Importation Rules

Sept. 12, 2013

The IRS released proposed regulations implementing the loss importation rules of IRC Sections 334 and 362. The rules are designed to prevent corporations from obtaining U.S. tax benefits from the acquisition of property with built-in losses in certain tax-free transactions. In the case of a capital contribution, tax-free reorganization, or subsidiary liquidation, a corporation subject to federal income tax normally takes a carryover tax basis in the property received. Without the anti-loss importation rules, the carryover basis rules allow the transferee to sell the acquired property at a loss. These rules frequently apply when the transferor is a foreign corporation not subject to federal income taxation.

The anti-loss importation provisions apply when the property received in the tax-free transaction meets all of the following characteristics:

  1. The fair market value of the property is less than its tax basis (a built-in loss is present).
  2. Any gain or loss on the property would not be subject to federal income tax if sold by the transferor immediately before the transfer.
  3. Any gain or loss recognized by the corporation on a disposition immediately after the transfer would be subject to federal income tax.

If the anti-loss importation rules apply, the basis of the property received by the corporation is reduced to fair market value. The proposed regulations clarify the following items:

  • The net amount of built-in gain and built-in loss on the property acquired from all transferors in a transaction is used to determine whether a Section 362 transaction is a loss importation transaction.
  • Built-in loss property transferred by foreign corporations subject to Subpart F to a corporation that is subject to federal income tax is loss importation property subject to basis reduction.
  • Built-in loss property transferred by a passive foreign investment company to a corporation subject to federal income tax is loss importation property subject to basis reduction.
  • In applying the rules to pass-through entities and grantor trusts, the proposed regulations look to the tax status owner/beneficiary to determine if the property is subject to federal income taxation prior to the transfer.
  • If some of the partners in a partnership are subject to federal income tax and others are not, the anti-loss importation rules apply only to the portion of the partnership’s assets attributable to the ownership of those members who are not subject to federal income tax.
  • An anti-avoidance rule applies to domestic trusts, estates, registered investment companies, real estate investment trusts, and cooperatives that directly or indirectly transfer property (including through other such entities) in a Section 362 transaction if such property was directly or indirectly transferred to or acquired by the entity as part of a plan to avoid the application of the anti-importation provisions.

For reorganizations and capital contributions, an election is available for the transferor to take a reduced basis in the stock of the corporation subject to federal income taxation in lieu of the corporation taking a reduced basis in assets. This election should be considered when appropriate.

The proposed regulations generally apply to transactions occurring on or after the date the regulations are issued in final form unless the transaction is completed pursuant to a binding agreement that was in effect immediately before the date the final regulations are published. The proposed regulations also contemplate that once the regulations are finalized, taxpayers will be allowed to apply the regulations to any transactions occurring after Oct. 22, 2004.

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